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Rumors Swirl Around a Cisco Play for VMware

VMware and Cisco

Cisco Systems' pursuit of virtualization software maker VMware could be more serious than many on Wall Street believed, as the network equipment maker searches for new sources of growth.

Cisco (NASDAQ: CSCO) has long coveted VMware, whose software helps computer servers run more efficiently and frees companies from having to maintain huge data centers. It went so far as to hold informal talks last summer to buy VMware's (NYSE: VMW) parent EMC according to a person familiar with the matter.

The companies did not move into formal negotiations, and tight credit markets make financing the purchase of a $25 billion company difficult these days. But things could change quickly if EMC (NYSE: EMC) decides to put VMware on the market.

"This is a logical deal to do," said a West Coast technology banker. "The question is, is it strategically compelling enough in this environment?"

Spokesmen for Cisco and EMC declined to comment.

Shares of VMware gained as much as 6.4 percent on Wednesday afternoon, while EMC shares rose as much as 3.3 percent, both on the New York Stock Exchange. Cisco edged lower on NASDAQ.

Jefferies & Co analyst Katherine Egbert said VMware shares rose on expectations that Cisco might buy EMC.

Trading volume for VMware also picked up in the equity options market on news of Cisco's interest in the company, according to Frederic Ruffy, option strategist at website WhatsTrading.com.

Virtualization is considered a hot technology that is changing the way companies store and manage their data. For Cisco, VMware could bring in a new source of revenue as the maker of switches, routers and other equipment -- the plumbing that manages much of Internet traffic -- faces maturing markets across its products and services.

VMware has a market value of $10 billion, a far easier sum for Cisco shareholders to swallow than a bid for the whole of EMC, the world's largest maker of corporate data storage gear. Cisco already owns 1.7 percent of VMware's common stock.

[cob:Pull_Quote]EMC previously said it had no plans to sell or spin off its 84 percent stake in VMware, but executives are expected to give an update on their strategy at a March 10 investor meeting.

Cisco CEO John Chambers has said the company plans to be acquisitive through the economic downturn. It has about $29 billion in cash and securities. On Monday, it launched a surprisingly large $4 billion debt sale.

Analysts have speculated that Cisco could be building a war chest for a large acquisition such as EMC, but a person familiar with the company's thinking said Cisco was just being "opportunistic" in tapping capital markets.

"They're taking advantage of low interest rates, and figuring they might as well get the money while it's there," the source said, adding that it was unlikely the debt issue is tied directly to any plan for EMC. The source was not authorized to speak publicly on the matter.

Rumors that Cisco could be interested in buying EMC to get its hands on VMware pushed EMC shares up 6 percent to $14.92 on July 30. The stock has since fallen amid concerns about global technology spending.

It is unclear whether EMC and Cisco discussed a price or terms during their conversations last summer, the source said.

Love triangle

EMC bought VMware in 2003 for $635 million, and owns 84 percent of the software maker after spinning the remainder out into a public company in 2007. VMware was the hottest technology stock that year.

Since then it has lost its shine due to slowing growth rates and increased competition from lower-cost products from Microsoft (NASDAQ: MSFT) and Citrix Systems (NASDAQ: CTXS).

[cob:Special_Report]That could be one concern if Cisco goes after VMware or EMC because the network equipment maker would be entering into competition with companies that traditionally have been among its biggest customers and partners.

Cisco, which supplies networking services for large enterprises, collaborates with software companies and other big technology players, including Hewlett-Packard (NYSE: HPQ) and IBM (NYSE: IBM).

"If Cisco buys just VMware, it's declaring war on Microsoft," said the West Coast technology banker. "If Cisco buys EMC, then they're declaring war in a very big way with HP and IBM."

With Cisco's debt issue this week fueling the deal speculation, the person familiar with Cisco's thinking said the company plans small- and medium-sized acquisitions.

Cisco has launched a debt offering only one other time in its history -- in 2006 to finance its $7 billion acquisition of television set-top box maker Scientific-Atlanta.

"Could it happen in 2009? Possible," another technology banker said of a Cisco-VMware deal. "But you'd have to see greater comfort that the economy is turning, and VMware would have to be separate from EMC, so that it's not a $30 billion plus acquisition."